Why Didn't Airlines Hedge against Higher Oil?

[Marina Schwarz + 1,576]

IATA executives are meeting in Australia for their annual meeting and:

"IATA, which represents about 280 airlines comprising 83 percent of global air traffic, in December predicted a record $38.4 billion of net profit for the airline industry in 2018, with $27.9 billion coming from U.S. and European airlines.

That estimate, however, assumed an average oil price of $60 a barrel in 2018. An updated profit forecast to be issued on Monday will be lower, as the cost of oil, infrastructure and labor rises, IATA CEO Alexandre de Juniac told reporters in Sydney on Thursday."

I also remember reading about airline execs being quite relaxed about higher prices. Why didn't they start hedging?

[Jan van Eck + 7,558]

Hedging costs money.  You have to pay a premium, the fee for engaging in the hedge trade, to participate.  But nobody knows if the price of oil is going up or down.  If the spot price goes down and you have bought oil on a futures contract, you have just thrown your money out the window.  And it can be a lot of money.  Suppose the situation where oil goes from $60 to $40.  But you bought your fuel for future delivery at $60  (or even higher, shudders).  Your costs for fuel are now locked in at 50% higher than the competition.  Do you want to run an airline under those circumstances?  Your competitors will eat your lunch.

Now suppose that nobody hedges and oil rises in price by say 20%.  You and all your competitors are still on an equal playing field. Are you hurt (in some relative sense)?  Nope.

[SLL + 24]

13 hours ago, Jan van Eck said:

Hedging costs money.  You have to pay a premium, the fee for engaging in the hedge trade, to participate.  But nobody knows if the price of oil is going up or down.  If the spot price goes down and you have bought oil on a futures contract, you have just thrown your money out the window.  And it can be a lot of money.  Suppose the situation where oil goes from $60 to $40.  But you bought your fuel for future delivery at $60  (or even higher, shudders).  Your costs for fuel are now locked in at 50% higher than the competition.  Do you want to run an airline under those circumstances?  Your competitors will eat your lunch.

Now suppose that nobody hedges and oil rises in price by say 20%.  You and all your competitors are still on an equal playing field. Are you hurt (in some relative sense)?  Nope.

While there are of course ‘fees’ (brokerage, etc) involved with hedging, it’s not like these guys needed to pay for a call option.  Brokerage is a normal cost of business for these guys.

If you have been paying attention the last 3-4 years, producers have been warning of this situation for a longg time.  Once the glut was worked off, underinvestment would snap prices the other way.

The cure for low prices, is low prices.

 

[Marina Schwarz + 1,576]

I thought after the 2016 trough it would be kind of clear prices would be going up. And so they did. But they didn't "embrace the cycle" as Reuters' Kemp put it very aptly. True, nobody can predict prices, though. Tough to be an airline exec, I guess.

 

This just in: 

SYDNEY, June 4 (Reuters) - Airlines are locking in fuel hedges, lowering capacity, raising fares and retiring older jets to cope with rising costs alongside the highest oil prices since 2014, industry executives say.

The squeeze from fuel costs, which have risen much faster than ticket prices, poses a particular threat to the industry’s profitability.

Edited June 4, 2018 by Marina Schwarz